1.1 – Overview

Fundamental Analysis (FA) is a holistic approach to study a business. When an investor wishes to invest in a business for the long term (say 3 – 5 years) it becomes extremely essential to understand the business from various perspectives. It is critical for an investor to separate the daily short term noise in the stock prices and concentrate on the underlying business performance. Over the long term, the stock prices of a fundamentally strong company tend to appreciate, thereby creating wealth for its investors.

We have many such examples in the Indian market. To name a few, one can think of companies such as Infosys Limited, TCS Limited, Page Industries, Eicher Motors, Bosch India, Nestle India, TTK Prestige etc. Each of these companies have delivered on an average over 20% compounded annual growth return (CAGR) year on year for over 10 years. To give you a perspective, at a 20% CAGR the investor would double his money in roughly about 3.5 years. Higher the CAGR faster is the wealth creation process. Some companies such as Bosch India Limited have delivered close to 30% CAGR. Therefore, you can imagine the magnitude, and the speed at which wealth is created if one would invest in fundamentally strong companies.

Here are long term charts of Bosch India, Eicher Motors, and TCS Limited that can set you thinking about long term wealth creation. Do remember these are just 3 examples amongst the many that you may find in Indian markets.

At this point you may be of the opinion that I am biased as I am selectively posting charts that look impressive. You may wonder how the long term charts of companies such as Suzlon Energy, Reliance Power, and Sterling Biotech may look? Well here are the long term charts of these companies:

These are just 3 examples of the wealth destructors amongst the many you may find in the Indian Markets.

The trick has always been to separate the investment grade companies which create wealth from the companies that destroy wealth. All investment grade companies have a few common attributes that sets them apart. Likewise all wealth destructors have a few common traits which is clearly visible to an astute investor.

Fundamental Analysis is the technique that gives you the conviction to invest for a long term by helping you identify these attributes of wealth creating companies.

1.2 – Can I be a fundamental analyst?

Of course you can be. It is a common misconception that only chartered accountants and professionals from a commerce background can be good fundamental analysts. This is not true at all. A fundamental analyst just adds 2 and 2 to ensure it sums up to 4. To become a fundamental analyst you will need few basic skills:

Understanding the basic financial statements

Understand businesses with respect to the industry in which it operates

Basic arithmetic operations such as addition, subtraction, division, and multiplication

The objective of this module on Fundamental Analysis is to ensure that you gain the first two skill sets.

Technical Analysis (TA) helps you garner quick short term returns. It helps you time the market for a better entry and exit. However TA is not an effective approach to create wealth. Wealth is created only by making intelligent long term investments. However, both TA & FA must coexist in your market strategy. To give you a perspective, let me reproduce the chart of Eicher Motors:

Let us say a market participant identifies Eicher motors as a fundamentally strong stock to invest, and therefore invests his money in the stock in the year 2006. As you can see the stock made a relatively negligible move between 2006 and 2010. The real move in Eicher Motors started only from 2010. This also means FA based investment in Eicher Motors did not give the investor any meaningful return between 2006 and 2010. The market participant would have been better off taking short term trades during this time. Technical Analysis helps the investor in taking short term trading bets. Hence both TA & FA should coexist as a part of your market strategy. In fact, this leads us to an important capital allocation strategy called “The Core Satellite Strategy”.

Let us say, a market participant has a corpus of Rs.500,000/-. This corpus can be split into two unequal portions, for example the split can be 60 – 40. The 60% of capital which is Rs.300,000/- can be invested for a long term period in fundamentally strong companies. This 60% of the investment makes up the core of the portfolio. One can expect the core portfolio to grow at a rate of at least 12% to 15% CAGR year on year basis.

The balance 40% of the amount, which is Rs.200,000/- can be utilized for active short term trading using Technical Analysis technique on equity, futures, and options. The Satellite portfolio can be expected to yield at least 10% to 12% absolute return on a yearly basis.

1.4 – Tools of FA

The tools required for fundamental analysis are extremely basic, most of which are available for free. Specifically you would need the following:

Annual report of the company – All the information that you need for FA is available in the annual report. You can download the annual report from the company’s website for free

Industry related data – You will need industry data to see how the company under consideration is performing with respect to the industry. Basic data is available for free, and is usually published in the industry’s association website

Access to news – Daily News helps you stay updated on latest developments happening both in the industry and the company you are interested in. A good business news paper or services such as Google Alert can help you stay abreast of the latest news

MS Excel – Although not free, MS Excel can be extremely helpful in fundamental calculations

With just these four tools, one can develop fundamental analysis that can rival institutional research. You can believe me when I say that you don’t need any other tool to do good fundamental research. In fact even at the institutional level the objective is to keep the research simple and logical.

Key takeaways from this chapter

Fundamental Analysis is used to make long term investments

Investment in a company with good fundamentals creates wealth

Using Fundamental Analysis one can separate out an investment grade company from a junk company

All investment grade companies exhibit few common traits. Likewise all junk companies exhibit common traits

Fundamental analysis helps the analysts identify these traits

Both Technical analysis and fundamental analysis should coexist as a part of your market strategy

To become a fundamental analyst, one does not require any special skill. Common sense, basic mathematics, and a bit of business sense is all that is required

A core satellite approach to the capital allocation is a prudent market strategy

The tools required for FA are generally very basic, most of these tools are available for free.

82 comments

Versity is good, however most of the charts given are not legible. The coordinate labels appear very small to read, probably on full HD display. Also the charts are marked by circle and arrow but not by word. For example while explaining the candlesticks the word doji, spinning top etc should be written.

Look for at least past 5-7 years of annual data. They say when a company completes every 7 years of business, it would have undergone 1 economic cycle. Hence when you look at 7 years of data, you will be factoring (and analyzing) 1 full economic cycle.

The Satellite portfolio can be expected to yield at least 10% to 12% absolute return on a yearly basis.
If the stock market is giving me just 10%, then why should I even care to do so much of hard work in analyzing stocks when I can get 9%(just a percent less) just by simply keeping it in the bank’s FD!!!

1) Long term Capital Gains tax is nil. Hence if you manage 12% on your portfolio over the last 365 days then do remember this is tax free
2) FD returns are taxable – so 9% after tax is about 7%. So contrast 7% versus 12%!
3) 12 % is a bit conservative…well managed Equity portfolios can generate over 15%
4) At 15% year on year your money will start working really well in your favor. To appriciate this point I would suggest you read the next chapter ‘Mindset of an Investor’, especially section 2.2.

Where can we find the industry data?? and i can not find 10 years of annual reports for many companies in their respective websites could only get hands on 3-5 years of data so what to do 10 years of data??

Usually the industry data is made available by the industry association/lobby. For example you can get all automobile data you could check SIAM – http://www.siamindia.com/ . I guess for historical AR you could check with the company directly, you will be surprised to know that most of the companies oblige and point you to the source.

Hi Karthik,
I read from Intelligent Investor that bonds and stocks should occupy 50:50 amount in portfolio. When stocks become expensive then bonds get valuable and vice versa. Because of your excellent articles I am now confident in stocks. But I know nothing about the bonds. So, could you please introduce a lesson about bonds?
Thanks,
Deepak

Impressed! Very interesting way of learning.
Is it possible on can target dividends in a short term trade? E.G. Today for company x’s dividend declared and buy on the same date then one can expect dividend? Please elobrate on complete process, declaration date, record date etc

Hi Karthik
This could be trading strategy related question. I have read in a book that the author invests in shares of a company and exits after a year leaving the profit and withdrawing the principal amount invested. Which leaves the profit money to grow and principal is safe (of course the principal shall be invested elsewhere in order to get benefitted).
What could be the disadvantages or advantages in this kind of approach?

Hi Karthik,
I have a basic question. As per most of the good investors it is advised that long term mindset should be set to become a successful investor in stock market. Companies performance does not contribute to the price of the shares as share price is totally dependent on investors emotion and market news. So how can we ensure that the current share price will not come down to its initial invested value after 5-6 years?

In the long run, it is the performance of the company that takes the stock price to its true value. As an investor one need to spend more time analyzing the business of a company rather than the price of a stock, this will naturally ensure your investments are safeguarded.

Hi Karthik, I am one among those who came into stock market without knowing what is Stock Market. I read few basic books (Intelligent Investor, Common Stock & uncommon profits, One up, Fooled by Randomness etc) to get a perspective. Very recently I can across varsity (Luckily!). It is very useful and I like the way you explain. All these basic books are completely against Technical Analysis. Could you please tell me if it is possible to get returns greater than FD rates by following technical Analysis CONSISTENTLY ? I did go through the fundamental analysis modules. Is it worth to dig deeper into Trading(Understanding Black & Scholes and trading strategies etc) ? Please clarify. Thank you .

Karthik, Thank you very much for replying. Looking at the winners, isn’t it the survivor bias (I am getting reminded of the Monkeys on the Typewriter analogy )? I am convinced that money can be made on long term(Thanks to you & Varsity team!). I am just skeptic about technical analysis and short term trading. If I learn more, does it help? is it wroth learning the TA or luck plays a major part?

There is no denying about the survivor bias here. But the practical problem is that its very hard to interview people who have lost money, they tend to shy away :). Read through the interview and treat it as just one set of inputs. Trading via TA requires a great amount of discipline, which let me assure you is not easy.

Here is what I’d suggest – spend time learning (the right way) and give it shot with smaller amounts of money. Scale only when you feel there is substance.

Is there any excel created for doing this kind of fundamental analysis. Just like you have created for knowing the current value of the stock. I know formulas are already there in this tutorial but it would helpful if we get an excel sheet for the same.

Karthik Sir – I’m still eagerly waiting for an excel sheet. I would be helpful to start doing research. Could you please let me know by when you are planning to put up module on Financial Modelling and excel sheet?

FA is indeed a very time tested investment philosophy. However I am keen to know how to take the first step ? For e.g. how to get a list of say 5-10 companies for further research and analysis. Do you suggest using some screeners or using Lynch’s approach ?

You can certainly start with screeners. Smallcase has just launched a screening tool which will help you identify stocks. Apart from this you generally need to develop a good investment mindset which will help you identify stock ideas. Yes, Lynch’s approach is a great way to start.

Previously pdf. version was also available for download and offline reading. PDF version is very convenient for self study and marking. But now I could not find a link to download content as pdf version. Please help.

I need to know where to get the quarterly reports as soon as they are published?

For example, few days back, Sun Pharma published q1 results. I checked their website immediately after reading thw news, but P&L statement was not there yet. Still I can see all the news about it. So from where do these news people get the information so fast?

Basically I am interested in getting to know the financial news of a scrip as soon as possible.